A private equity firm with ~$4 billion in assets under management built an automation facility for its portfolio companies. I find this interesting for two reasons.
- First, I’ve written about how private equity firms use management-company resources to compound knowledge across a portfolio (Vista Equity Partners example). This is the first time I’ve seen that idea pushed to robotics and automation.
- Second, private equity firms do not commit to infrastructure lightly. You can buy a portfolio company in secular decline at the right price. But what you build at the management company, the entity that employs the individuals and captures the knowledge and processes that work across funds, should be timeless.
As Bradley Jacobs writes in How to Make a Few Billion Dollars, one of the most valuable pieces of advice he received was from his mentor Ludwig Jesselson: “You can mess up a lot of things in business and still do well as long as you get the big trend right.”
The US is increasingly investing in domestic manufacturing, and labor constraints are highlighting the need to explore automation. I’ve seen it most pronounced supporting Stephen Gould’s aerospace and defense division, which takes me to conferences where US-made components are increasingly discussed as a matter of national security.
But this extends far beyond the industry I’ve been focused on, and it’s interesting to see how investors are responding. And that brings us to the ~$4 billion private equity firm: MiddleGround Capital.
MiddleGround Capital Automation Team
MiddleGround Capital specializes in industrial manufacturing and specialty distribution businesses. Roughly 40% of MiddleGround’s team also comes from operational backgrounds, including experience working in factories.
The firm has assembled a team of roughly a dozen engineers and fabricators, many recruited from a Toyota plant near its Kentucky headquarters. The team designs and builds automated manufacturing cells and then trucks the finished systems to MiddleGround portfolio companies.
Owning this process allows them to explore efficiency at a more granular level. Per the PE firm, most of the projects they explore don’t meet the scale most automation firms require, which is frequently a minimum of $1 million capex.
In effect, MiddleGround is investing behind the same thesis twice. It deploys investor capital into manufacturing businesses, then invests management-company resources in automation capabilities it believes those businesses will increasingly need.
This also highlights the value of specialization in private equity (and the decline of the generalist fund). A dedicated robotics team would be difficult to justify across a generalist portfolio. Across a concentrated portfolio of manufacturing businesses, the same expertise can be deployed repeatedly, with knowledge from one project carried into the next.
Who Pays for It?
This is where the economics get interesting. The management company could pay some or all of the team’s salaries and overhead from its management fee revenue. But this could be a scenario where the portfolio companies reimburse the firm for specific automation projects or expenses.
If it’s a combination of the two, it could be a powerful incentive for result-driven outcomes. At MiddleGround portfolio company Race Winning Brands – the leading manufacturer and marketer of racing and high-performance engine components – an automated forging machine developed by the robotics plant is expected to generate $9 million in equity value.
I can’t say for certain, but if the portfolio company pays the automation team for this outcome, the private equity firm wins in several ways: (1) support or offset the cost of maintaining the automation team, (2) increase in portfolio-company equity value, and (3) retaining the knowledge and processes generated by each project.
Note: In some ways not dissimilar to working with a company like ReBuild or Nottingham Spirk, except the scale of the portfolio allows you to build and own this process in house.
How is This a Shift for PE?
This is a combination of compounding knowledge around repeatable systems that make a company successful and getting the major trend right.
Private equity firms need to find ways to increase value. Bain & Company has been making this point for years. In its latest Global Private Equity Report, Bain argues that with low prices, cheap debt and easy multiple expansion gone, generating attractive returns will require faster EBITDA growth and much sharper value creation.
The firms that win will need to build systems and capabilities that turn an investment thesis into operating results.
More Links / Continued Reading:
- Pitchbook: Ground control to private equity: has AI landed on the factory floor?
- MiddleGround: Buyouts: Unlocking Value Through Automation
- Bain Capital: Global Private Equity Report